No V-Shaped Recovery

Without foresight, L-shaped aftermath may occur.

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This weekend, Barron's declared the existence of a Treasury bubble, encouraging its readers to consider high yield municipal and corporate bonds as an alternative. Everywhere I turn, I find another market pundit suggesting the equity market has bottomed, or the commodity bust is over.

And -- for a short-term trade -- I don't necessarily disagree.

But for one to believe we have truly bottomed at this point, you have to believe in a V-shaped recovery.

Put simply, I don't. In fact, I am somewhere between a U- and an L-shaped recovery - certainly nowhere near a "V."

The following is a list of the world's 25 largest financial institutions as of the end of 2007:

I hope it's immediately clear that every one of these firms has been adversely affected by the current crisis - some enormously so. By my count, 4 have been fully nationalized; all the rest have received what I consider to be "controlling" interests by their home governments.

More importantly, these firms -- along with maybe another 10 or 15 financial-services firms (all of whom have been similarly affected), dominate the global credit markets and represent somewhere between 60% and 75% of the world's total lending capacity.

So, to put things very simply: Credit = government, at least until further notice.

While I will leave it to others to debate whether this outcome is a just reward for management negligence, at best -- or malfeasance, at worst -- like it or not, strategic decisions for these firms and their ilk aren't going to be made by private-sector capitalists on Wall Street or in Canary Wharf. Instead, they'll be made by the public servants of the largest governments around the world.

And here's where the rubber meets the road - or doesn't, as the case may be.

In watching the behavior of governments worldwide, it appears their general operating principle right now comes from A Field of Dreams: "If we build it, they will come." That is, if banks would just make money available, people would borrow anew, and the global economy would quickly recover.

But the bubble that just burst was a credit bubble, and more credit isn't going to make everything better. banks need to recognize their losses and rebuild capital, so that they will ultimately be in a position to lend when asset prices finish falling.

In the hands of government, however, I highly doubt this will happen anytime soon - particularly as loss recognition calls the adequacy of government oversight into question. Instead, under government influence, we will do whatever we can to postpone our losses.

Having spent a considerable amount of time in Japan during the early 1990s, I watched this happen firsthand and in real time: Bankers and bureaucrats both unwilling to face reality for fear of losing face. It was immensely frustrating, but it gave me great insight into how governments handle large-scale crises.

So, to all those declaring a market bottom: You are putting your fate in the hands of government. As for me, with history as my guide, I will gladly sit this one out - and watch "V" become "U," and, if we aren't careful, "L."

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